NEW YORK (Reuters) - Coca-Cola Co <KO.N will take over the North American operations of its top bottler, Coca-Cola Enterprises Inc CCE.N, in a strategic reversal that would level the field after a similar deal by PepsiCo.
In return for taking control of the North American business, Coke will relinquish its 34 percent stake in CCE, worth $3.2 billion based on Wednesday’s closing price. It will also assume $8.88 billion in CCE debt.
The deal will help the world’s largest soft drinks maker cut costs and increase flexibility in distributing its beverages, which range from Diet Coke and Sprite to vitaminwater and Minute Maid.
Coke's announcement on Thursday comes just as PepsiCo Inc PEP.N is due to close this week on the $7.8 billion purchase of its largest bottlers, Pepsi Bottling Group Inc PBG.N and PepsiAmericas Inc PAS.N.
“Coke couldn’t sit back while Pepsi delivered $600 million (plus) in synergies for reinvestment and then transformed its U.S. business model,” said ConsumerEdge Research analyst Bill Pecoriello.
But investors were surprised by the deal. Chief Executive Muhtar Kent has repeatedly said he was committed to a franchise model that kept bottling operations separate, even when asked directly about ramifications from Pepsi’s deal.
“Even those of us who thought this would happen eventually will be shocked by the timing,” said JP Morgan analyst John Faucher.
Kent said Coke’s strategy in North America was primed for change after two decades of retail consolidation and the growth of smaller, niche drinks.
"You don't need to think about this being played out in other markets," Kent said. He declined to comment on the possibility of buying Coca-Cola Bottling Co Consolidated COKE.O, a smaller U.S. bottler whose shares rose 6.4 percent.
CCE shares rose 33 percent to $25.51 in afternoon trading, while Coke’s shares fell 4.3 percent to $52.77.
News of the deal boosted shares in Dr Pepper Snapple Group DPS.N by nearly 9 percent, as analysts expect it could receive a payout of up to $1 billion to allow Coca-Cola to continue distributing its drinks.
TO BUY, AND SELL AGAIN
Over the long-term, Coke may decide to sell the North American operations to Coca-Cola Femsa KOFL.MX, its Latin American bottling venture with Mexico's FEMSA FMSAUBD.MXFMX.N, according to ConsumerEdge's Pecoriello. Coke's CEO did not rule out such a scenario.
“Once we put it all together and realize these synergies and efficiencies, I see a very meaningful role for partnerships in the United States in our business,” Kent told reporters.
JP Morgan’s Faucher said the deal implied a multiple of about nine times operating earnings for the North American business, which he said “seems awfully rich”.
Coke Enterprises will become purely focused on Europe, with assets in countries including France and Belgium. As part of the deal, it will buy Coke’s bottling operations in Norway and Sweden, and have the right to buy the controlling interest in Coke’s German bottling business.
CCE will make a one-time payment of $10 a share to its stockholders, who will also receive shares of the new company.
UBS analyst Kaumil Gajrawala said he thinks the new CCE would be worth about $33 per share, or roughly $23 per share after the dividend.
CCE will keep its name and U.S. stock listing. It is expected to announce a $1 billion share buyback shortly after the deal closes, expected in the fourth quarter of 2010, and plans an initial annual dividend of 50 cents per share.
The deal has been endorsed by the boards of both companies but still needs approval from two-thirds of CCE’s minority shareholders, who will likely vote on it in the summer, said CCE Chief Executive John Brock.
“We think it’s a pretty robust victory for shareowners,” Brock said on a call with reporters.
CCE’s North American business comprises about 75 percent of Coke’s U.S. bottler-delivered sales volume and almost all of its Canadian bottler-delivered volume.
The companies agreed in principle that CCE would pay $822 million for Coke’s bottling operations in Norway and Sweden, which together generate annual sales just north of $700 million. CCE will also have the right to acquire the soft-drink maker’s 83 percent equity stake in its German bottling operations 18 months to 36 months after closing.
COMBINING BUSINESSES IN THE US
Under the current business model, Coke sells beverage concentrate and CCE bottles and distributes the drinks. But the structure has at times been a source of tension over issues such as the price Coke charges for its concentrate or the size of the budget used for promotions.
Coke will combine the CCE bottling business with its foodservice business, its Minute Maid juice business and its supply chain business, which includes some company-owned bottling operations in Philadelphia.
Coke, which will have no equity stake in the new Europe-focused CCE, expects the transactions to add to earnings by 2012. It also expects cost savings of $350 million over four years, with 70 percent of the savings realized by the end of 2012. It expects a one-time charge of $425 million over three years, but will not need to use any additional borrowings.
Moody’s Investors Service affirmed Coke’s short- and long-term credit ratings, saying the deal will not “materially change the financial metrics of the consolidated system.”
Allen & Co and Goldman Sachs were financial advisers to Coca-Cola, while Credit Suisse and Lazard served as financial advisors to CCE.
Additional reporting by Jessica Hall in Philadelphia; Editing by Michele Gershberg, Maureen Bavdek, Tim Dobbyn, Leslie Gevirtz
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